1. Figure 8.3: Subprime Lending Fiasco – U.S. Housing Bubble U.S. Housing Bubble Unsustainably High House Prices Very Low Interest Rates Excessive Foreign Savings Mortgage Securitization & Resale Greed & Conflicts of Interest Transfer of Risks From Lenders To Investors Bad Mortgage Loans Liar, No doc, Ninja, No deposit Bad Ratings Lack of Transparency Misguided Regulators House Prices Crash Unsuspecting Investors Lose Jobs, Pensions Government Bailouts Public Pressure Public Pressure

2. Figure 8.1: Subprime Lending Fiasco – Stages Enabling the Housing Market Securitization starts Credit default swaps Banks can speculate No leverage limits Stimulation starts Building the Housing Bubble More stimulation, low int. Securitization transfers mortgage risk to investor so lender can take poor risks Unlimited investor demand for mortgage-backed securities Competition to loan leads to subprime loans, inflated house prices, more securitizations Credit ratings inflated The Housing Bubble Bursts 2007-8 Economy slows Subprime loan defaults rise Foreclosures rise deflating house prices Walk-aways rise Securitizations default Insurers cannot pay Investors fail Liquidity/credit crisis Bailouts start The Aftermath Subprime mortgage loan defaults rise Economy slows further as failure cycle continues Liquidity/credit crisis continues Investment banks fail TARP bailouts and liquidity support continue Stocks crash Securitization insurers fail Insurance companies fail Contagion spreads worldwide Countries become insolvent Worldwide bailouts start Restrictions start on business and capital markets More quantitative easing (QE2)

3. Figure 8.2: Subprime Lending Fiasco – Key Events 1997 1 st Publicly Available Securitization of CRA loans 1999 Gramm-Leach- Bliley Act allows banks to speculate 2000-2 Commodity Futures Modernization Act allows banks to trade in Credit Default Swaps Recession gives rise to stimulus: lower interest rates, housing tax credits, subsidies, liquidity increases 2003-4 Loan standards discarded Securitization grows Bank leverage limits suspended allowing unlimited borrowing to buy subprime mortgage- backed securities 2005 Credit default swaps allowed as insurance on subprime collateralized debt obligations Housing market boom stops 2007 Housing bubble bursts as house prices fall Subprime lending collapses, failures Foreclosures rise Bear Stearns halts redemptions on two funds Stock market peaks Credit crunch begins Liquidity & bailout measures begin 2006 U.S. Housing prices fall Subprime lenders start to fail Smartest investors start to reduce subprime exposure (J.P. Morgan, Goldman-Sachs) 2008 Home prices plummet Credit default swap insurance fails Bear Stearns sold to J.P. Morgan Banks fail, Bailouts start, Fannie Mae & Freddie Mac taken over Bk. of America buys Merrill Lynch Lehman Bros. Bankrupt AIG & Iceland bailed out Washington Mutual & Wachovia taken over. Stocks crash Troubled Asset Relief Progr. (TARP) Massive bailouts, liquidity support 2009 Contagion worldwide Fears over Irish, UK, European banks Short-selling restrict. in Japan UK, France Quantitative easing GM Bankrupt Flash crash TARP: exec. comp. restricted & repayments start 2010 European Debt Crisis – Greece, Ireland, others Greece bailout U.S. foreclosure crisis 2 nd Quantitative easing wave (QE2) Rating agency reform Fin. Enforcement Task Force created Flash order ban Dodd-Frank Act Sources: Timelines documents from the Federal Reserve Bank of New York and Wikipedia

4. Lehman’s Bankruptcy Update: A statement from Ernst and Young: Lehman's bankruptcy occurred in the midst of a global financial crisis triggered by dramatic increases in mortgage defaults, associated losses in mortgage and real estate portfolios, and a severe tightening of liquidity. We firmly believe that our work met all applicable professional standards, applying the rules that existed at the time. Lehman's demise was caused by the global financial crisis that impacted the entire financial sector, not by accounting or financial reporting issues. http://www.cbsnews.com/8301-18560_162-57417397/the-case-against-lehman- brothers/?tag=pop;stories http://www.cbsnews.com/8301-18560_162-57417397/the-case-against-lehman- brothers/?tag=pop;stories